For weeks, the Central Bank has been raising the exchange rate daily at a rate of its own choosing. In this sense, an undeclared and therefore implicit system of fixed exchange rate appreciation is in effect. This policy has been particularly evident since the end of August Such exchange rate regimes have both positive and negative aspects. Let me start with the positive aspects.
First, the exchange rate is the most important determinant of inflation in Turkey. Moreover, it is calculated that the effect of an increase in the exchange rate on inflation has increased sharply in the last two years. In a paper presented at a conference organized by the Economic Institute of Turkey in Kemer, Hakan Kara pointed out that during the years when inflation fluctuated around 8 percent, the effect of a 10 percent increase in the exchange rate on inflation fell below 1.5 percentage points, but with inflation jumping in recent years, this effect has now exceeded 5 percentage points. Therefore, if you are implementing a policy that controls the exchange rate increase, you have a better chance of controlling inflation.
Second, the exchange rate affects not only the demand for domestically produced goods through foreign trade. It also affects supply, especially by changing the cost of imports of intermediate goods. The paper I presented at the same conference shows that, within the framework of a model based on this feature, exchange rate increases can be limited by a risk-reducing program, especially in periods of high risk and thus high exchange rate increases, and thus the production-dampening effects of high exchange rate increases can be mitigated.
Third, expectations about the future value of the exchange rate are very important in countries like ours. It affects not only foreign trade decisions but also physical and financial investment decisions and consumption. If the exchange rate increase is controlled, this reduces uncertainty and allows for more comfortable and healthy decision-making.
Of course, in order for these positives to be more apparent, the implementation of such an exchange rate regime would have to be announced with a drum roll, and moreover, the targeted monthly rates of increase in the exchange rate would have to be announced. Given that in this environment such a drumbeat is unlikely to be possible, it is up to ‘smart’ commentators like me to say, “look, we have a fixed exchange rate regime; the monthly increases are this much”.
Now for the downside – and this is closely related to the fact that announcements are impossible. When you make a commitment by making a public announcement, you have to prevent the exchange rate from deviating from the path you have announced in advance. In other words, you have an exchange rate level to maintain. This is possible in two ways: By raising interest rates and/or selling foreign exchange. It is not possible to sell what we don’t have; it is not that we don’t have any, but it is very insufficient; we want to increase the reserves. Raising interest rates to protect the exchange rate contradicts the inflation targeting policy that is supposedly being implemented. You should use interest rates to fight inflation. OK, if you raise interest rates to rein in the exchange rate, you will also help inflation, but the signals are mixed; in short, you cannot have both an exchange rate target and an inflation target.
When you make a public announcement, there is another important obstacle. We cannot yet finance our current account deficit through normal means. In addition, our foreign debt maturing over the next year has exceeded 210 billion dollars. Foreigners are hesitant to come in; they are obviously not convinced that the program will be sustained. Under these circumstances, it is almost suicidal to announce a fixed rate of increase exchange rate regime and to commit to the level of the exchange rate. In the end, we end up in the same place. If it is sustainable, an appreciating fixed exchange rate regime is fine for a country like ours. But the 100-point question remains: Is such a policy sustainable under current conditions? Since the answer is ‘for now’ in the negative, the regime being implemented is not publicized; and since it is not publicized, its positive effects are limited.